The present invention generally relates to a new method and system for managing securitized interests in pools of collateral, such as, for example, collateralized debt obligations (“CDOs”), to satisfy portfolio investment ratings requirements.
Investors generally use independent ratings from ratings services, such as, for example, Moody's Investors Service (“Moody's”), to help price credit risk of securities they may purchase or sell. Many also use ratings as limits on their investment parameters and as means for expanding their investment horizons to markets or security types they do not cover by their own analyses. Because investors globally rely on ratings, the ratings help to provide issuers of debt with stable, flexible access to those sources of capital.
Any type of debt or related obligation of interest to institutional investors can be rated, e.g., bonds, debentures, asset-backed and mortgage-backed securities, convertible bonds, medium-term notes, derivative securities, etc. While the present disclosure utilizes the example of CDOs, which, as described in greater detail hereinafter, are securitized interests in pools of (generally non-mortgage) assets, it should be appreciate that the present invention is not limited to CDOs but has application with respect to other types of securitized interests as well.
Conventionally, managers of CDOs structure the underlying collateral such that the CDO will satisfy certain collateral quality requirements established by an independent ratings service, such as, for example, Moody's (e.g., Moody's Diversity Score Test, Minimum Average Recovery Rate Test, Weighted Average Rating Factor Test and Weighted Average Margin Test), which requirements can be represented in the form of a collateral quality matrix (“Matrix”), to, in turn, meet the requirements of a particular ratings category (which ratings, for Moody's system of gradation, range from C (the lowest) to Aaa (the highest)). An abbreviated (showing only six rows) example of a Moody's Matrix is set forth below in Table 1.
TABLE 1RowDiversityRecoveryWARFMargin14044.232,07023524044.232,30030034544.232,16523544544.232,30027554044.482,30029564544.482,385295
Diversity refers to the diversity score required to satisfy the Diversity Score Test developed by Moody's for CDO risk analysis. The diversity score of a given pool of participations (debt instruments of various obligors) is the number n of collateral (e.g., bonds) in an idealized comparison portfolio where (i) the total face value of the comparison portfolio is the same as the total face value of the collateral pool; (ii) the collateral of the comparison portfolio have equal face values; (iii) the comprarison collateral are equally likely to default (independently); (iv) the comparison collateral have the same average default probability as the participations of the collateral pool; and (v) the comparison portfolio has the same total loss risk as the collateral pool.
Recovery refers to the minimum average recovery rate required to satisfy the Minimum Average Recovery Rate Test of Moody's. It is a measure of the fraction of an exposure that may be recovered through bankruptcy proceedings or some other form of settlement in the event of a default. Recovery rate assumptions are based, generally, on historical recovery rates for loans and bonds.
WARF refers to the weighted average rating factor required to satisfy the Weighted Average Rating Factor Test of Moody's. It is a numerical measure relating to Moody's system of gradation by which relative credit worthiness is represented (e.g., portfolio collateral issued or guaranteed by the United States government might be assigned a Moody's Rating Factor of 1 which corresponds to the Aaa Moody's rating category).
Margin refers to the weighted average margin (in bps) required to satisfy the Weighted Average Margin Test of Moody's. It is a measure of the difference between market value and face value of collateral.
A disadvantage associated with the Matrix is that it offers the CDO manager only limited flexibility in purchasing and selling collateral to satisfy ratings requirements. The present invention fills this gap by providing a method and system for a CDO manager to satisfy portfolio investment ratings requirements without having to adhere to the strict parameters of the Matrix.